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Turkey’s inflation: rate cuts on the agenda again

Many in Turkey began the New Year wishing for a brighter economic future, but it looks as though 2019 will be the same old same old.

December consumer price inflation (CPI) of 20.3 percent was met with virtual jubilation by Treasury and Finance Minister Berat Albayrak last week and he triumphantly announced the government’s end of year economic targets had been met. The official central bank inflation goal remains 5 percent and the central bank’s estimate for 2018 inflation at the start of the year was 7.9 percent.

The government revised, or rather was forced to revise, its economic estimates across the board following a currency crisis that struck between May and August. The new figures were unveiled under its New Economy Plan in late September. That plan, which partially reflected the extent of damage to the economy, had envisaged 20.8 percent CPI for end-2019.

If that 20.8 percent estimate is to be taken as “the” benchmark, forgetting about the 5 percent official goal and the central bank’s 7.9 percent prediction, then of course the realisation of inflation of 20.3 percent appears almost right on target. Yet, really, can this be called a success?

Source: Turkey Data Monitor

The drastic spike in Turkey’s inflation was the main trigger and at the same time the painful result of the currency crisis that the country went through for most of 2018. The lira’s late-found stability, or relative stability, throughout the fourth quarter is now proving to be fragile again given concerns about global economic growth.

Interestingly, looking at Turkey’s mainstream media, there were serious assertions that the December inflation numbers would pave the way for central bank rate cuts as early as March-April. Optimism is being pumped up that the “worst is over” for the Turkish economy.

There is no need to say that such early rate cuts, which will definitely be seen as the central bank yielding to political pressure, would have a disastrous effect on the Turkish economy through more lira weakness. The credibility gap that the central bank has suffered of late is still very much alive. That means any further monetary policy mistakes will reflect strongly on market sentiment. Investors are yet to be convinced of the central bank’s reversal towards orthodoxy seen in September, when it hiked interest rates by 625 basis points to 24 percent to avert a full-blown financial crisis.

The credibility gap is all the more apparent when a country’s official inflation target is 5 percent and inflation is 20.3 percent. Yet, the argument against not engaging in monetary easing goes far beyond the central bank’s credibility problem.

Turkey’s inflation is not likely to slow as rapidly as the government desires. The reasons are:

The minimum wage increase for 2019 was 26 percent compared to the government’s new 15.9 percent inflation goal. This follows a 20-percent pay hike delivered in 2018. What we saw at the start of 2018 was that such minimum wage increases stimulated domestic demand. But the Turkish economy is not the same as it was at the start of 2018 when first quarter GDP growth was 7.4 percent. In fact, the growth picture for this quarter is almost the exact opposite of the situation last year because a 5-percent economic contraction may be on the cards. The minimum wage increase could well hurt inflation and speed up a pass-through whereby producer price inflation, currently 34 percent, impacts consumer price inflation of 20.3 percent, because producer may be forced to pass on higher costs.

The consumption tax cuts introduced in the fourth quarter of last year have now been extended through the first quarter. The measures have had almost no impact on domestic demand because of the higher interest rates that are now prevalent. But they are generating lower revenue for the public accounts. What the tax cuts have done is to help consumer price inflation fall faster from a 15-year peak of 25.2 percent in October. The decision to continue with the tax cuts can help pull headline CPI lower than the end-2018 level of 20.3 percent. Yet, once those tax reductions are reversed, CPI will gain pace again.

The lira matters. The lira’s belated stability combined with the rapid drop in the price of oil has helped the government on the inflation front, especially in December. Yet, as worries intensify about the pace of global economic growth, the Chinese slowdown, trade wars and Fed-ECB policy actions, volatility in emerging market currencies has escalated. The lira is no different and when a country’s currency is volatile following an immense currency crisis, lowering inflation becomes a harder task.

On the domestic front, given the countdown to local elections on March 31, in which the ruling Justice and Development Party (AKP) is expected to lose votes due to the economy, the government has chosen to deal with rising bad debt in the banking sector by restructuring most of it and hiding it under the carpet of healthy loans. Yet, as the banking watchdog recently acknowledged, bad loans are set to increase rapidly throughout 2019. The lira will be affected negatively by the government’s choices in dealing with this problem.

There are still so many uncertainties in the Turkish economy that seem to be preventing a rapid decline in inflation. As long as the lira is stable, “what goes up must come down”. Yet with no room left for further lira appreciation - foreign investors keep deserting the economy - and with the prospect of premature rate cuts blurring decision-making, double-digit inflation is here to stay for longer than the government expects. Looking ahead, I would expect CPI inflation of 17 percent to 19 percent by the end of 2019, rather than the slowdown to 15.9 percent that the government envisages.